About two years ago the research described here circulated widely. Since it was not in the public domain, our review of the work went only to private clients seeking our opinion. Proprietary research is not peer reviewed. While many buy-side firms have staff capable of interpreting sell-side research, we wonder how many spotted the flaws in this analysis.
The work was done by a first-rate team from a major firm. We do not have the underlying data, and we are not publishing their proprietary work. Instead we have made a few minor changes. We have substituted a different interest rate series, highly correlated with the one actually used. Briefly put, this is our own analysis. The chart depicted is a spitting image of the one that was circulated widely and repeatedly. Take a careful look, and form your own conclusion about what you see.
The author, writing in late 2004, concluded that rising interest rates would lead to a reduced PE multiple for the market. One can readily see that this conclusion is consistent with the derived regression equation. Rates were about 4 percent, and (given Fed action) seemed to be moving higher, suggesting a lower multiple.
The scatter plot challenge to readers is to spot any problems with this research. It is a difficult challenge. We shall post our own answer tomorrow.